Risk case

Debt lev­els in China have be­come a ma­jor fo­cus for pol­i­cy­mak­ers, but ex­perts don’t al­ways agree

A new book, China’ s Guar­an­teed Bub­ble, by Zhu Ning, a pro­fes­sor at Ts­inghua Univer­sity, ar­gues that many Chi­nese do not prop­erly un­der­stand risk.

We are see­ing a more se­ri­ous ap­proach from the gov­ern­ment, and it is be­gin­ning to al­low de­faults and bank­rupt­cies.”

Jeremy Stevens, China-based econ­o­mist at Stan­dard Bank

Is China fac­ing a debt bub­ble? Hous­ing prices have soared by more than 30 per­cent in many of the coun­try’s tier-one cities, such as Bei­jing and Shang­hai this year alone.

Re­search by the Na­tional In­sti­tu­tion for Fi­nance & De­vel­op­ment, one of China’s na­tional-level think tanks and part of the Chi­nese Acad­emy of So­cial Sci­ences, put China’s debt at 249 per­cent of GDP in 2015.

A new book, China’s Guar­an­teed Bub­ble, by Zhu Ning, pro­fes­sor of fi­nance at Ts­inghua Univer­sity, makes the ar­gu­ment that many Chi­nese do not prop­erly un­der­stand risk.

It says there is now a dan­ger­ous cul­ture emerg­ing in China of peo­ple re­gard­ing in­vest­ing in prop­erty and other as­sets is a one-way bet and that if any­thing goes wrong the gov­ern­ment will bail them out.

Lev­els of debt in China have be­come a ma­jor fo­cus for pol­i­cy­mak­ers.

There have also been re­cent con­cerns about a credit crunch hap­pen­ing some­time be­fore Chi­nese New Year, as was the case in the runup to the fes­ti­val in 2013. This has been re­flected in higher bond yields, with 10 out of 19 banks and bro­ker­ages in a Bloomberg sur­vey say­ing that 10-year sov­er­eign yields will rise to 3 per­cent by the end of the year.

The gov­ern­ment re­cently made clear its com­mit­ment to con­trol­ling debt. It an­nounced strict guide­lines on Nov 14 to strengthen bud­get man­age­ment at the lo­cal gov­ern­ment level.

How­ever, ac­cord­ing to one of the lat­est ma­jor in­ter­na­tional com­par­isons of debt by the McKin­sey Global In­sti­tute for the sec­ond quar­ter in 2014, China did not par­tic­u­larly stand out. Its debt level then was 217 per­cent of GDP, rank­ing it 22nd among in­debted na­tions, well be­hind Ja­pan which had the high­est ra­tio, 400 per­cent. France was 280 per­cent, the United King­dom 252 per­cent and the United States 233 per­cent.

Andrew Le­ung, founder of Andrew Le­ung In­ter­na­tional Con­sul­tants and a lead­ing China com­men­ta­tor, says a lot of the dis­cus­sion about China’s debt un­der­es­ti­mates the strength of the coun­try’s as­sets.

“You can’t just look at debt. You have to look at debt and eq­uity. If peo­ple bor­row money to buy a house, they have the as­set of a house. A lot of China’s as­sets are worth se­ri­ous money.”

The main con­cern is the speed at which China’s debt has risen. Ac­cord­ing to Bloomberg In­tel­li­gence, it grew 465 per­cent in the decade up to 2015, with cor­po­rate debt (mainly that of state-owned en­ter­prises) in­creas­ing from 105 to 165 per­cent of GDP.

Fred Hu, chair­man of China-based global in­vest­ment firm Pri­mav­era Group and for­mer greater China chair­man for Gold­man Sachs, says China is still deal­ing with the con­se­quences of the 4 tril­lion yuan ($580 bil­lion) stim­u­lus that was in­jected into the econ­omy af­ter the global fi­nan­cial cri­sis in 2009.

“The debt has ex­ploded to a very high level within just five to six years. His­tory has shown that episodes of fast credit ex­pan­sion in­evitably lead to mis­al­lo­ca­tion, ris­ing non­per­form­ing loans, bank­ing sec­tor stress and ul­ti­mately a fi­nan­cial cri­sis,” Hu said.

Louis Kuijs, head of the Asia section at Ox­ford Eco­nomics, based in Hong Kong, be­lieves ris­ing debt is a se­ri­ous is­sue but con­sid­ers a fi­nan­cial cri­sis un­likely be­cause the banks have a healthy de­posit base.

“I do not think that a sys­temic fi­nan­cial cri­sis is likely any­time soon be­cause the bulk of the debt is owed do­mes­ti­cally and the fi­nan­cial sys­tem is still very liq­uid, with a loan-tode­posit ra­tio well be­low 100 per­cent, un­like in any typ­i­cal coun­try that has fallen into a fi­nan­cial cri­sis in re­cent decades,” Kuijs said.

Le­ung says this is an ad­van­tage that China has over the United States and many Euro­pean coun­tries: Al­most all of its debts are owed in­ter­nally within its own fi­nan­cial sys­tem.

“There is very lit­tle ex­ter­nal debt,” Le­ung said. “In this case China is very sim­i­lar to Ja­pan, and very dif­fer­ent to most West­ern coun­tries.” Ja­pan also has a sav­ings cul­ture and strong de­posit base.

“It is cer­tainly a pos­i­tive, although run­ning up do­mes­tic debts is not cost-free, as it tends to put down­ward pres­sure on the cur­rency and will add strains in the bank­ing sec­tor,” he said.

“How­ever, pol­i­cy­mak­ers have more con­trol over the sit­u­a­tion than they would have if debts were owed abroad. China’s high do­mes­tic sav­ings rate makes it eas­ier to bor­row do­mes­ti­cally, so that is an­other ad­van­tage it has.”

One of the main ar­gu­ments in the book by Zhu, the Ts­inghua pro­fes­sor, is that in­vest­ments in China of­ten ap­pear to have some sort of im­plicit guar­an­tee from the gov­ern­ment, thereby cre­at­ing ir­ra­tional be­hav­ior.

He said wealth man­age­ment prod­ucts of­fered by banks and other fi­nan­cial in­sti­tu­tions some­times offer 20 per­cent re­turns while claim­ing there is no risk to cap­i­tal.

Michael Pet­tis, pro­fes­sor of fi­nance at Bei­jing Univer­sity’s Guanghua School of Man­age­ment, be­lieves it is a “moral hazard” ques­tion that needs to be ad­dressed in China.

“It is what we call the process by which prof­its are re­tained by in­vestors and all or a sig­nif­i­cant pro­por­tion of the losses are passed on to some other en­tity like the gov­ern­ment,” he said.

“It cre­ates a sys­temic ten­dency to over­in­vest or to in­vest in ex­ces­sively risky projects, be­cause it elim­i­nates most of the down­side for in­vestors by pass­ing losses on to the gov­ern­ment. I wouldn’t say Chi­nese in­vestors have no un­der­stand­ing of risk. On the con­trary they un­der­stand very well and are tak­ing ad­van­tage.”

Jeremy Stevens, Bei­jing-based China econ­o­mist at Stan­dard Bank, Africa’s largest bank, be­lieves the gov­ern­ment is be­gin­ning to tackle the prob­lem.

“We are see­ing a more se­ri­ous ap­proach from the gov­ern­ment, and it is be­gin­ning to al­low de­faults and bank­rupt­cies and pro­vide the in­sti­tu­tional frame­work in which bank­rupt­cies can be un­der­taken. This change has been in­cre­men­tal and prob­a­bly not bold enough quite yet,” he said.

For many, the most con­cern­ing po­ten­tial bub­ble in China is the hous­ing mar­ket, where prices have been soar­ing in tier-one cities. Bei­jing and Shang­hai now boast some of the high­est house prices in the world, although the coun­try it­self has a long way to go to achieve high-in­come sta­tus.

Ge­orge Mag­nus, se­nior econ­o­mist at UBS in Lon­don, said there are par­al­lels be­tween China and many West­ern coun­tries in the runup to the fi­nan­cial cri­sis in the last decade.

“There was an as­sump­tion that prop­erty prices would con­tinue ris­ing. The West­ern credit bub­ble was built around the idea of home own­er­ship in Bri­tain and the US, and in Spain and Ire­land, although it was not a typ­i­cal con­ti­nen­tal (Euro­pean) prob­lem.”

Pet­tis, also au­thor of Avoid­ing The Fall: China’s Eco­nomic Re­struc­tur­ing, be­lieves the hous­ing price boom may have some way to go be­fore it be­comes a bust. “An un­sus­tain­able rise in real es­tate prices can per­sist for much longer than economists ex­pect,” he said.

“Be­fore they fell in the early 1990s, for ex­am­ple, Ja­panese real es­tate process prob­a­bly ex­ceeded fair value by at least twice as much as Chi­nese real es­tate prices do to­day.”

Stevens at Stan­dard Bank says fi­nan­cial crises al­ways tend to re­sult from the li­a­bil­i­ties side of the bal­ance sheet rather than on the as­sets.

“So far, the gov­ern­ment has been re­solv­ing ten­sion in the sys­tem by fo­cus­ing on the as­sets side and push­ing through ex­cess ca­pac­ity cuts on the sup­ply side of the econ­omy and in­tro­duc­ing curbs to pre­vent spec­u­la­tion on the hous­ing mar­ket,” he said.

“What is hap­pen­ing on the fund­ing side is more up for de­bate. The prob­lem is that you need credit growth in the econ­omy to de­cel­er­ate.”

Some ob­servers be­lieve the Chi­nese gov­ern­ment needs to move away from its tar­get to dou­ble its 2010 GDP by 2020 if it ex­pects to break out of the mid­dle-in­come trap and be­come a high-in­come econ­omy.

To meet this tar­get it needs to achieve 6.5 per­cent growth ev­ery year. This year growth has been 6.7 per­cent in each of the first three quar­ters.

Pet­tis es­ti­mates that in achiev­ing the goal this year alone, debt rose 15 to 20 per­cent.